SELECTING TOP STOCKS TO BUY
“SelectingTop Stocks to Buy”is a series of articles that focuses on the process of selection of stocks for investment. In this series, we have learned about:
Part 1:Getting the right perspective towards stocks investing & the qualities required to become a successful investor,
Part 2:Different stock picking approaches & the guidelines for selecting the suitable stock picking approach,
Part 3:The process of shortlisting stocks for detailed analysis & various tools available to an investor for shortlisting of stocks ,
Part 4:The framework of detailed analysis of a company, Part 5:Understanding the annual report of a company, Part 6:Financial analysis of a company,
Part 7:Valuation analysis of a company,
Part 8:Business & industry analysis of a company and Part 9:Management analysis of a company
In previous articles, I have provided readers with key takeaways in form of crucial parameters that an investor should use while analyzing stocks. Articles
on financial analysis, valuation analysis, business & industry
analysisandmanagement analysiscontained summary checklists that can be very handy for any investor.
In the current article, I have compiled at one place the parameters that an
investor should check each stock, before investing her hard-earned savings. This article can serve as a final checklist for any stock market investor, which will become very useful while doing detailed analysis of stocks.
To see a live example of analyzing a stock on these parameters to
determine whether it has the qualities of an investment-worthy stock, you should read: Equity Research - Ambika Cotton Mills Limtied. In this article I have analyzed Ambika Cottom using the parameters listed above. Investors should always keep in mind that, no checklist could ever be complete for doing stocks analysis. However, the parameters in the above test any companyand its stock on some of the tough performance
parameters. Hence, an investor can be reasonably certain that the stocks, which pass the above checklist, have sound fundamentals and are
available at reasonable valuations. If she diligently follows these
parameters, invests only in stocks that promise good fundamentals and never overpays for them, then she can be assured of good returns from her portfolio over long term.
Temporary periods of stock price fluctuations, business cycles where even good companies would not be able to maintain sales growth & profitability would definitely come in between. However, the investor should keep her patience and not act on impulse and stay invested in a company until the time inherent business strength of the company is intact. She would reap great benefits of such investing behavior.
No checklist is paramount. Hence, an investor should not restrict
themselves to the parameters mentioned above. She should read further about investment analysis and add/remove parameters from the above list as per her understanding.
Monitoring stocks in an investor's portfolio is also equally important. An investor should delineate her monitoring activities into ongoing activities, quarterly activities and annual activities.
GETTING THE RIGHT PERSPECTIVE TOWARDS INVESTING
Every investor has a dream that she should create a portfolio of stocks, which should generate wealth for her. The portfolio should become an alternative source of income for her. The portfolio should support her in the hard work to sustain and improve the financial position of her family, her lifestyle and if possible give her an opportunity to retire early and fulfill all her dreams: travel, adventure and doing things she is passionate about. I have the same dreams and desire that my stock portfolio should generate sufficient income; so that I might not need to work at a job as a necessary means to earn my livelihood. Monitoring my portfolio would be the only thing needed and I do not think of portfolio management as a job. It is my passion, which makes me feel lively and rejuvenated.Many acclaimed people have already achieved that dream through stock investments, both in India and abroad. The accomplishments of Warren Buffett and Rakesh Jhunjhunwala can be cited as good examples. Warren Buffett buys the stakes and stocks in the companies, in which he would like to, invests through his parent holding company Berkshire Hathaway. Those companies, in which he has invested earn profits and send majority of the cash back to the parent company (Berkshire), which Warren further invests. Warren, currently 84 years of age, enjoys his job so much that he often says that if loving one’s job ensured long life, then he would never die. His personal wealth is about $ 67 billion. I do not know whether my portfolio would ever be able to reach those levels. It is in the time to come, when we will see how far I will be able to go. I believe that anyone who is able to put in the required hard work can do the same.
What is needed to be a Good Stock Picker?
Reading: It is the single most important quality required in a
successful investors like Benjamin Graham, Peter Lynch etc. have written books sharing their knowledge about stock investments. They have explained the stock picking process in a very simplified manner. Reading these books is the first step in this journey of stock investments.
Patience & Emotional Control: This is another very important
quality needed for a good stock market investor. The role of emotions in investments has assumed such significance that a separate field called “Behavioral Finance” has been created for it. Stock market investing requires a long-term approach and you have to stay invested in the market for a long time to reap the benefits. Investors face many emotions during their stay in the stock
market. Emotions like fear, greed and frustration make investors take impulsive decisions of entry and exits during short phases of market ups & downs. When stock prices go up, the investors try to make short-term profits and thus sell their investments
early. Many times, after investors sell, stock markets keep on rising further and investors are not able to reinvest their money and
market runs away from them. Market movements are highly unpredictable. Investors need to stay invested in stocks of good companies for long periods to make significant wealth. Jeanne Sahadi, a CNNMoney.com senior columnist writes:
"Missing out on those high-return months (the timing of which you can't predict) can cost you a lot. A hundred dollars invested from 1926 to 2006 in the S&P 500 would have yielded $307,700, according to Ibbotson. But if you missed the 40 months with the highest returns you would have ended up with - no kidding - $1,823 only."
When stock prices go down, many investors fail to analyze the reasons of fall in the stock prices. Some investors are gripped with fear. They sell a good company whose stock price had fallen due to general market
sentiment and not due to poor performance of the company. They should actually be buying more stocks of that company at cheaper valuations. Other investors show opposite behavior and do not sell a poor performing company despite huge decline in its stock price because they hate to book losses. It is said that one should buy stocks; the way they buy their
vegetables & groceries; one should buy more when prices are down. Therefore, one needs to be in control of one’s emotions and should
develop the patience to delay the short-term gratifications. One should be able to visualize the wealth, which markets are able to create over very long periods. Reading about the behavior of successful investors and observing their actions during different phases of stock markets, will help in developing the emotional control required to be a successful investor.
A Degree in Finance: Finance & investing are not rocket science.
Business families have been able to teach fundamentals of finance to their children within confines of their homes. The same phenomenon of simple conceptual understanding always stands true in finance & investing. You need to get clarity on some basic concepts of finance and you would have gained the foundation to start investing. Good reading habit will help you to build on that foundation.
Advanced Mathematics: You do not need to be a mathematician to
succeed in stock market investing. The math you will need for investing is taught during school education. You do not require more than the ability to carry out the basic calculations. If someone says that, you need advanced mathematics for investing, she is confusing you and you should ignore such advice.
Investing requires a lot of common sense and control of emotions. If you are able to learn basic concepts, are able to read further to build upon the existing knowledge and keep patience & self-control during stock market highs & lows, then you have what it needs to become a successful
investor.
How to Start Investing:
Once one has read the required books of successful authors, the person will be able to understand the basic framework about stock market functioning. She will also get to know about various characteristics and parameters of stocks to be looked into while doing stock investment. She should note down and keep a list of these parameters with her when analyzing stocks to see how these parameters apply when doing actual stock analysis.
Then she should start exploring stock markets to identify the best stocks for her. Financial newspapers (e.g. Business Standard, Economic Times etc), business magazines (e.g. Business Today), stocks magazines (e.g. Dalal Street, Capital Markets etc) and websites (e.g. Moneycontrol etc.) are good sources to start looking for potential stocks for detailed analysis. I have read some of the successful investors and have
prepared some stock picking guidelines, which have helped me in selecting good stocks over the years. I have prepared these guidelines by reading books and learning from my experiences in stock market investing over last few years. These guidelines keep on getting improvised further as I keep learning new lessons.
This concludes the first part of a series of articles about the process of Selecting Top Stocks to Buy. Please let me know how you think about stock investing and the process that you follow.
I will cover the various approaches towards stock market investing in my next post. This series of articles will cover detailed discussion on my stock picking guidelines. I will write about the avenues to search for stocks and to get the required information for analysis. The steps to analyze the gathered information and to make decisions based on such information will be covered in the next parts of this series.
CHOOSING THE STOCK PICKING APPROACH SUITABLE TO
YOU
If we read about the experiences of successful investors, we will find that each one of them had their own specific methodology of picking stocks. They in turn, might have been inspired by other successful investors. However, there is not any one specific approach of stock picking, which has made them successful.
Benjamin Graham focused on investing in stocks that were selling at a discount to their fair value. This is an example of Value Investing
approach. Philip Arthur Fisher (Phil Fisher) focused on investing in stocks that were capable of growing at a faster pace as compared to their peers. He justified paying a premium for such high growth stocks and did not stress too much on finding stocks selling at a discount to their fair value. This is an example of Growth Investing approach.
Warren Buffett studied under Benjamin Graham during college and therefore focused more on value investing in the initial stages of his career. However, later on, he incorporated guidelines of Phil Fisher in his investment philosophy. Now, as per Buffett, his investment methodology is a mix of about 85% Graham and 15% Fisher.
So we can see that there is not only one single defined approach to achieve success in stock picking. In fact, it is rightly said that ‘All roads lead to Rome’. However, each one of these approaches has their own pros and cons. These stock-picking approaches might differ in terms of the types of the stocks they focus on. These approaches might also differ in terms of the amount of time & effort required from investors and in many more ways. A stock-picking approach, which is suitable for one investor may not be suitable for another. However, it is easy to find the stock-picking approach or a mix of the approaches, which will be suitable for an investor. This article would help the readers in find such a suitable stock-picking approach.
I have discussed various approaches to stock picking below. We, as investors, should learn a bit about these different stock-picking
approaches and then select the approach or the mixture of approaches, which appeals to us.
Fundamental Analysis: Fundamental analysis of a stock involves
understanding the underlying business of a company. While doing
fundamental analysis, the investor tries to find out a company, which has a very good product, well-known customers, stable suppliers, honest & capable management etc. Once the investor finds such a company, she can invest in its stock and expect to benefit from the future growth of the business of the company. Fundamental analysis is very similar to the in depth analysis, which an entrepreneur will do before starting a new
business. I believe that the fundamental analysis approach to stock picking is, in fact, a form of entrepreneurship.
Technical Analysis: Technical analysis involves analyzing charts of the
past movements of a stock’s price and its trading volume over the
different time periods. It involves understanding the patterns in the charts containing data of a stock’s price movement in the past. The investor then tries to predict future price movement of the stock based on these past patterns. Once the investor finds a stock whose price is expected to move higher, she buys it and holds it until the chart patterns indicate that the price is expected to fall or become stable. The investor following technical analysis is concerned only with the past prices and trading volume data of the stock. The investor is indifferent to whether the stock is of a
manufacturing, an agricultural or a financial services company.
Comparison between Fundamental Analysis and Technical Analysis:
Most of the successful stock market investors have followed the
fundamental analysis. Fundamental analysis treats stock investment as a way of having ownership in a company’s business. This approach allows an investor to benefit from the enormous wealth, which is generated by owning a successful business over a long period of time. On the other hand, Technical analysis tries to predict the next ‘up move’ in a stock’s price and is indifferent to the company’s business.
In fundamental analysis, once an investor has found a good company, she stays invested in its stock for decades. Hence, if the investor was able to make at least a few good stock investing decisions in her life, she will be able to earn a great amount of wealth. In technical analysis, the investor buys a stock just before the next ‘up move’ in its price. She sells the stock after the up move has happened or if the up move does not occur and the buying decision has been proved wrong. In technical analysis, the investor keeps the stock with herself only for a few days or weeks. Many a times, investors try to buy and sell stocks with a few minutes during a day. Such kind of investment behavior requires the investor to keep finding right stocks every few minutes/days/weeks.
Almost all the successful investors say that finding good stocks for investment is difficult. Therefore, if an investor has found such a stock, then she should stay invested in it for long periods. Selling a good stock only after one ‘up move’ in its price is not a winning decision in long term.
Stock markets are very volatile and the periods of up & down moves in a stock’s price are going to be very frequent. Therefore, an investor should not fall prey to greed and she should not sell her stock when the prices move up immediately after she buys it. Moreover, the investor should stay invested in the stock until the company keeps on growing its business consistently.
I started stock market investing in 2006 by learning technical analysis. However, with the continued reading and personal experiences in stock picking, I realized that fundamental analysis is a better approach to stock picking. Therefore, I have been selecting stocks by using fundamental analysis since 2008. I have written about my reasons to shift from technical analysis to fundamental analysis in detail here.
Different sub-approaches under Fundamental Analysis:
Fundamental analysis has different sub-approaches to stock picking. All these sub-approaches focus on underlying business of the companies. However, they differ in the methods of selecting stocks for detailed analysis and the features of stocks, which are focused for future gains.
Top Down and Bottom Up approaches:
Top Down approach: Top down approach to the fundamental analysis is
also called EIC (economy-industry-company) approach. In top down
approach, an investor tries to identify those economies (countries) of the world, which are expected to grow at a faster pace than other economies. Once the investor has found such economies, she studies them in detail. Within these economies, the investor tries to identify the industries, which are expected to witness higher growth than other industries. Once the investor has identified high growth industries in selected economies, she tries to find out the companies in these high growth industries, which are expected to benefit the most from such expected growth. Once the
investor has finalized the list of such companies, she buys stocks of these companies. The investor expects to benefit from the higher earnings, which these companies are expected to create over next many years.
Bottom Up approach: Bottom up approach to the fundamental analysis
involves identifying companies, which are expected to grow their business without restricting the stock-picking search to any particular industry or economy (country). All the stocks listed in all the stock exchanges in the world, irrespective of country or industry of operation, are open for
selection to the investor. The investor uses various selection criteria to search for the best stocks. Such selection criteria help an investor find out the companies he likes e.g. the fastest growing companies across all sectors or the companies, which are selling at a discount to the cash in their bank accounts. Once the investor finds a good company, he buys its stock and expects to benefit from the future growth of the business of the company.
Comparison between Top Down and Bottom Up approaches:
Top down approach limits an investor’s analysis to stocks of only a few countries and a few industries. However, bottom up approach does not have this limitation. Bottom up approach provides an investor the option of investing in those companies, which are doing very good but are in industries, which are currently not doing well. Such companies are known to make huge wealth for investors. Peter Lynch, fund manager of Fidelity Magellan Fund from 1977 to 1990, has recommended investing in such companies in his book One Up on the Wall Street.
Thus, we can see that bottom up approach gives an investor more options to choose his stocks for investment.
Growth Investing and Value Investing approaches:
Growth Investing: In growth investing approach to fundamental
analysis, the investor tries to find such companies, which are expected to witness a very high growth in business performance in future. Once the investor has found such a company, she buys its stocks. The investor expects to benefit from future high growth of the business of the company.
Value Investing: The investor following value-investing approach of
fundamental analysis tries to find the fair value of the stock of a company by analyzing various business and financial parameters of the company. After calculating the fair value of the stock of a company, the investor compares it with the current market price on a stock exchange. If the investor finds that the current stock price of the company is lower than the fair value of its stock as per her calculations, she buys the stocks of the company. The investor expects to benefit from the increase in the stock price after market discovers the discount in the stock value and increases the stock price to its fair value.
Comparison between Growth Investing and Value Investing approaches:
In growth investing approach, the investor puts more focus on future growth of the company and ignores the current valuation levels of its stock as compared to ongoing/past performance of the company’s business. The investor buys its stock at whatever price it is currently available in the stock market.
Value investing approach of stock picking is equivalent to finding goods selling at a discount in any market place e.g. a grocery store. A value investor will not buy the stock of a company, which is expected to show good business performance in future, if its stock is currently selling at a price higher than its fair value. The value investor would think that the current expensive valuation has already increased the price of the stock of that company to such an extent that the potential of increase of the stock price in future is limited. The investor would ignore this company and start
the search for another company whose stock is priced at a discount to the fair value.
If an investment decision goes wrong, then the risk of suffering losses, is much more in growth investing, as it does not focus on the current
valuation of the stock price. If a company selected by growth investing approach does not grow as expected or its growth slows down a bit, the stock market will punish its stock. In such a case, the stock prices will fall very fast and the investor might lose a lot of her invested capital.
However, in case of companies selected by value investing, if the stock market does not realize the discount available in the stock of a company soon, then its stock price might not increase in the short term. However, it would provide the investor with an opportunity to accumulate more stocks of this company. Thus value investing approach has a higher "Margin of Safety" as described by Benjamin Graham.
It is said that the market may keep ignoring the discount available on a stock for a very long time. Therefore, stock investing should have a very long-term investment horizon. It is similar to investment in family land or real estate. You do not sell the land or property for every day-to-day financial need. Similarly, it is recommended not to sell stocks for day-to-day financial requirements and look at them from a very long-term perspective preferably in decades.
My approach to Stock Picking:
We have discussed the major approaches to stock picking. We have also seen comparative features of different stock picking approaches. It was mentioned in the beginning of this article that every investor should choose an approach or a mix of approaches, which she likes. After reading books of various successful investors, who had followed different stock picking approaches mentioned above and after personal experience of about 8 years of investing in Indian stock markets, I have found the following mix of stock picking approaches, which I like:
Fundamental Analysis: As previously mentioned, I prefer fundamental
analysis for stock picking as compared to technical analysis. I like fundamental analysis because it treats an investor as an owner of the company and the fundamental investor needs to make only a few right investment decisions in her life to make significant wealth as compared to a technical investor. On the other hand, the technical investor needs to be on the lookout for right stocks almost daily.
Bottom Up approach: I prefer bottom up approach as compared to top
down approach. If an investor follows top down approach, she would find that the stocks of the companies, which are expected to do good in high growth industries of such economies (countries), which are expected to outperform other economies, are already overpriced. This limits the choice of stocks available for her investments unless she decides to overpay for
them. In bottom up approach, the investor focuses on the good companies irrespective of the industries and economies. Therefore, she is able to select stocks of good performing companies from all the industries whether these industries are growing at a fast or at a slow pace. If the investor follows bottom up approach to stock picking, she would have better chances of finding out companies, which are growing at a fast pace but whose stocks are priced at a discount currently.
Mix of Growth Investing and Value Investing approach to Fundamental Analysis:
I follow a mix of growth and value investing approaches. I search for companies, which have grown their earnings at a good pace in past and their earnings are expected to keep growing in future. Once I have prepared a list of such high growth companies, I try to find out the
companies from this list, whose stocks are currently selling at a discount in the market. This is like having best of the both worlds and many
readers might think that it won't be easy to find such companies.
However, Indian stock markets are under-penetrated and only a few well-known stocks are well researched by market analysts. Most of the large investors like FIIs, mutual funds etc. focus on only about 400-500 stocks of large companies out of more than 5,000 companies listed on Indian stock exchanges. An investor can find the hidden gems among these balance 4,500 stocks, which are not getting analyzed by stock market analysts. These hidden gems offer an opportunity to invest in high growing
companies, which are available at very reasonable stock prices. I focus on this under-analyzed segment of Indian stock markets to find potential stocks for my portfolio.
Thus to summarize, I follow a bottom-up fundamental analysis approach in which I look for high growing companies available at attractive stock prices.
Any person who wants to be an investor can learn about these approaches for stock picking. The investor can focus on the approaches which she finds suitable for her according to her temperament, work schedule, life style etc. The investor can choose to pick the best of the characteristics of various stock picking approaches and mix them to create an approach of her own.
Once the investor has decided about her stock picking approach, she should start searching for companies whose stocks meet her criteria. The investor should keep on improvising her approach by incorporating
lessons, which she would learn from further readings and personal experiences in stock picking.
At the start of Warren Buffett's investing career, no one could tell whether he would be the most successful investor of all times. No one could
predict about the success of Benjamin Graham, Peter Lynch or Phil Fisher. Similarly, no one knows whether you and I are going to become successful & wealthy investors. However, the current requirement is to put in the necessary effort in stock picking and wait for the future to unfold the results. Various investors have become successful in the past. I believe that I can be successful at stock picking and so can be anyone else who is willing to put in the required effort.
This concludes the second part of this series of articles about the process of Selecting Top Stocks to Buy. Please let me know how you think about stock investing and the process that you follow.
In the next article in this series, I will elaborate on individual stock analysis. I will highlight the characteristics, which make any company investment worthy. The article would help the reader select companies, which she can trust with the investment of her hard-earned money.
Further, in this series of articles to find top stocks to buy, I will write about the avenues to search for stocks and to get the required information for analysis. I will discuss the steps to analyze the gathered information and to make investment decisions based on such information.
SHORTLISTING COMPANIES FOR DETAILED ANALYSIS
In the first article of this series (Getting right perspective towards Investing), we discussed about getting the right perspective towards stock investing and the requisite qualities for becoming a successful investor. In the second article of this series(Choosing the Stock Picking Approach suitable to you), we learned about different stock picking approaches available to an investor and the guidelines for selecting the stock picking approach suitable to her.The current article in this series, aims to highlight the necessity of
shortlisting a few companies for detailed analysis, out of the thousands of companies available to an investor. We would also learn about various tools, which an investor can use for shortlisting these companies.
As per Bombay Stock Exchange website, at September 14, 2014, there are 5,471 stocks available for investing. Each of these stocks represents a company running a unique business. Business of each of these companies is different from all the other companies whether they are from the same or different industries.
For example, a pharmaceutical company will have a business entirely different from a telecom company. Moreover, within the pharmaceutical companies, a company selling its products in Indian market will have a very different business from another company, which sells its products in overseas markets. Among pharmaceutical companies, which focus on overseas markets, a company, which sells its products in US & other
developed countries will have a different business than the company, which sells its products in Africa & other developing countries.Therefore, investing in any company will expose an investor to a business that would be very different from investing in any other company.
Therefore, investing in stocks of one company will produce very different results than investing in stocks of any other company. Therefore, it is suggested that an investor must be very particular about choosing the companies in which she invests her hard-earned money.
An investor should analyze a company in detail before adding it to her portfolio. However, it is very difficult for any investor to analyze all the companies available for investment. Their number stands at 5,471 today and is expected to increase in future. Therefore, every investor should use a process for filtering out all the companies that do not meet her
requirements. She should then focus on the remaining companies to find out the companies, which she feels are the best. Such companies will prove to be great investment opportunities for her.
The process of shortlisting companies is necessary so that an investor can focus her limited time and effort on a few targeted companies. Shortlisting companies before analysis helps an investor get maximum benefit out of her effort.
DIFFERENT METHODS FOR SHORTLISTING COMPANIES FOR DETAILED ANALYSIS:
There are many different methods used by investors to shortlist companies for analysis. Some of the common methods are described below:
Magazines: There are many magazines that are focused on stock
markets e.g. Dalal Street, Capital Markets etc. These magazines regularly publish many articles with basic analysis of companies. If an investor reads these magazines regularly, she can select the companies mentioned in these magazines, which she likes, for detailed analysis. However, an investor should not invest in any company just because it is recommended by these magazines. These magazines should serve merely as a source to select stocks for detailed analysis. Final decision should always be based on investor’s own analysis.
Newspapers: Similar to magazines, many newspapers have business sections and publish stories about different companies. If an investor likes any company based on a news article, she should analyze it further in detail, before making investment decision. Television: Many TV channels have special programs, which give
coverage to growing companies. Such programs present good analysis of company’s history, its brands, its customers etc. They also feature interviews with the company’s management. These
programs can be a good source of information for selecting companies for detailed analysis.
However, all these methods, which use mainstream media to shortlist companies have a limitation. Mainstream media usually covers those companies, which are famous and the market has already recognized the value of their stocks. Therefore, stocks of such companies usually sell at a premium and potential for future price increase is generally limited.
Therefore, many investors try to use sources where they can find companies, which have potential for high growth in their business and whose stocks are not yet recognized by the markets. Some of such methods are mentioned below:
Local Marketplace: Many investors try to find companies suitable
for investment by focusing on bestselling products in the local markets. They visit malls, shops etc. to find out about the most selling products and the shops that sell them. One of the successful investors, Peter Lynch, has written that he had taken many
investment ideas by observing the products bought by his wife and children. If an investor decides to follow this approach, she should find out whether the companies, which make the highly demanded products, are available for investment on any stock exchange. If yes, then she should analyze these companies in detail. This approach is best for identifying companies in consumer goods industries.
Online Stock Screeners: Stock screeners are tools provided by
different websites, which allow investors to search for companies that meet their investment criteria. Once an investor mentions her stock picking criteria, these websites show her a list of companies meeting her search criteria. Then, the investor can analyze these companies further. An investor should select her stock picking
criteria based on the investment approach that she finds suitable to her as detailed in the part 2 of this series.
My Method of shortlisting companies for detailed analysis:
I follow a bottom-up fundamental analysis approach in which I look for high growing companies available at attractive stock prices. After reading books of successful investors and based on personal
experience in stock investing, I have prepared a list of stock picking criteria. These criteria can be used with the stock screening tools of different websites. These criteria help me in shortlisting companies for detailed analysis, which are growing fast but are yet to become famous. I am confident that at the end of this series of articles “Selecting Top Stocks to Buy”, all the readers would be able to make their own stock picking criteria, which would help them select stocks based on their stock
picking approach. Such criteria would reflect the personal approach of every reader and will help her proceed on her stock investing journey.
Online Stock Screeners available to Investors:
Once an investor has formed her stock picking criteria, all she needs is a tool for searching companies based on these criteria. Now a day, there are many websites, which offer online tools to investors for shortlisting
companies based on their criteria. These websites are paid as well as free ones:
Paid Websites: E.g. CMIE, Capitaline. These paid websites charge an annual fee of a few lakh rupees for providing their services. Free Websites: E.g. screener.in, equitymaster.com, askkuber.com
Paid websites offer more features than the free websites. However, an investor should consider paid websites only if she has a very large
portfolio. Free websites are good enough to meet analysis requirements of an individual investor. I believe that if an investor's portfolio is smaller than INR 10 cr, then she should not use paid websites, as annual charges of paid websites would be a significant cost to her portfolio.
My favorite online stock screening tool is www.screener.in. It is a very simple to use website. It has very elaborate instructions for helping the first time uses.
I have given below a few screenshots demonstrating the step-by-step
approach for using its stock screener. I have used a sample set of stock picking criteria for this demonstration.
In the above screen, I have searched for companies where:
Sales have grown by a compounded annual growth rate (CAGR) of 15% for last 10 years.
Price to earnings ratio is less than 10 Debt to Equity ratio is less than 1
Cash generated from operation is positive and Market capitalization is greater than INR 25 cr.
One can see that there are 56 companies out of the total 5,471
companies, which meet the sample shortlisting criteria. Now an investor can focus her time & effort on analysis of these 56 companies and ignore the balance 5,415 companies. An investor can click on each company's name to find out more details about each company in the search results.
Balance Sheet details for last 10 years:
Cash flows details for last 10 years:
Thus, we can see that now a day, some very useful tools for information on stocks & companies are available to every investor. Stock selection is no longer a field reserved for only a few big investors. Any common investor, including you and me, can search for great companies and analyze them in detail.
In current era, to become a successful investor, all we need is the right approach towards stock investing, some amount of hard work and an internet connection!
In next part of this series, I will elaborate on the detailed analysis of shortlisted companies. In the future articles in this series, we shall learn about deciding whether the shortlisted companies are good investment opportunities.
HOW TO CONDUCT DETAILED ANALYSIS OF A COMPANY
In this series, we have learned about getting the right perspective towards stocks investing & the qualities required to become a successfulinvestor ( Part 1 ), different stock picking approaches & the guidelines for selecting the suitable stock picking approach ( Part 2 ) and the process of shortlisting stocks for detailed analysis & various tool available to an investor for shortlisting of stocks ( Part 3 ).
The current article aims to provide a framework for the detailed analysis of any stock before we delve deep into the threadbare analysis of any company for making investment decision about its stock.
It is said that there is no single path to success. Similarly, there is no single defined way of analysis to find a good company. Investors can analyze a company in many different ways depending upon their stock picking approach.
FUNDAMENTAL ANALYSIS
Growth Investing Approach:
An investor, who follows growth-investing approach of fundamental analysis, would like to study a company like an entrepreneur. She would focus on a company’s product, target market, suppliers, customers, management, financials etc. She would want know the strength and sustainability of the business of a company. Her aim is to find a company that is going to increase its earnings in future. Her belief is that when a company increases its earnings, the demand for its stock will increase. Increasing demand of the stock would lead to increase in the price of the stock of the company. The investor would gain from increase in stock price as well as dividends to be received from the company in future.
She focuses on finding companies, which have a sustainable business advantage, which can last for decades so that she need not shift out of the stock of a company every few days. She thinks like the owner of the company and remains invested in it for decades.
Value Investing Approach:
An investor, who follows value-investing approach of fundamental analysis, would focus on finding fair value of the company. She would focus on the assets and earning potential of the companies. She tries to find out the companies whose stocks are priced at a discount to the fair value. The deeper the discount she can find, the better it is!
MY APPROACH TO STOCK INVESTING:
I follow a bottom-up fundamental analysis approach in which I look for high growth companies whose stocks are available at attractive prices. I focus on finding companies, which have grown their sales & profits at a good pace in past and have the business strength to keep growing in future. I look for companies, which have low debt as it offers safety & a potential future route to raise funds. I try to find out companies whose stock is selling at low valuations so that it can offer a huge margin of safety. I believe that if earnings of a company increase then stock price would also rise. However, no one knows the timing of stock price rise and this is the uncertainty/risk, which requires patience of staying put with good stocks. The patience of staying invested in good companies is rewarded handsomely.
Detailed Analysis of a Company:
I divide the analysis of any company in four sections: Financial Analysis, Business & Industry Analysis, Valuation Analysis & Management Analysis There is no particular order in which an investor should approach these sections. One may start from financial analysis or management analysis. However, all the four sections are essential and none can be left
unanalyzed.
A) FINANCIAL ANALYSIS:
The aim of financial analysis is to analyse the amount of income it earns in sales, amount of profits it is able to retain for shareholders after factoring in all expenses & taxes and the growth in sales & profits over past.
Financial analysis also focuses on the sources of funds, which a company has used for creating its assets. It also involves the analysis of the amount of cash it generates from its operations and utilization of this cash,
whether for investments or debt repayment etc. The aim is to find
companies, which have a healthy financial position that can offer potential for future growth.
Financial analysis involves reading of annual reports of a company. It comprises of detailed analysis of three main financial statements:
Profit & Loss Statement (P/L):
This section of financials provides details of total income that a company has earned in a year (also called Topline). It provides details of all the expenses the company has incurred to earn the topline. It also provides details of the taxes the company paid to the govt. authorities. The part of topline, which remains after meeting all the expenses and taxes, is called net profit or Bottomline.
I focus on companies which earn a lot of money (topline), use minimum amount to earn that money, pay due amount of taxes on its profits and increase the sales (topline) & earnings (bottomline) year on year.
Balance Sheet (B/S):
This section of financials provides details of all the assets and liabilities of a company at the last date of the financial year. In Indian context, it
provides details at March 31 of any given year.
Liabilities are the sources of funds, which a company has utilized to purchase all the assets it owns. The usual sources are shareholder’s own money (equity), retained earnings (profits earned but not distributed to shareholders) and debt (borrowings from banks and other sources)
Assets provide details of utilization of the money raised under liabilities. Assets comprise of fixed assets, investments and current assets. Fixed assets are permanent fixtures that generate revenue year after year for the company e.g. plant & machinery. Investments reflect the money that the company has invested in different other companies, joint venture, subsidiaries etc. which are expected to earn money for company’s
shareholders. Current assets are usually consumed within next one year. Current assets include inventory that gets consumed and gets sold as finished product within a year, cash & similar investments kept by the company to meet day to day requirements and money due from
customers (account receivables or debtors) and loans given to different parties that are expected to be received back within a year).
I focus on companies, which use minimum amount of debt and create assets that keep on generating revenue for the company year after year without the need of frequent expenses to maintain these assets.
Cash Flow Statement:
This section provides details of the cash that a company has generated in last financial year from operation (cash-flow from operations or CFO). This section also includes details of cash used in making investments or
received from selling investments (cash-flow from investing activities or CFI) and cash raised from financial institutions as borrowings or repaid to them during the last year (cash-flow from financing activities or CFF) I focus on companies, which generate good amount of cash flow from operations that can take care of their requirements of investment (CFI) and repayment of debt (CFF). If a company generates so much cash that after taking care of CFI and CFF, it still has surplus left, it is a dream company and I buy as many stocks as I can (Shop till you drop!!).
Some knowledge of accounting can be a good advantage to do financial analysis of a company. However, it is not required to be a master of accounting for stock investing. An investor who does not have a background in finance & accounting, but is willing to put in the effort needed to read the annual reports, will get the required knowledge of accounting during analysis. Therefore, I firmly believe that anyone irrespective of educational background can be a great stock picker.
B) BUSINESS & INDUSTRY ANALYSIS:
I am a bottom up fundamental investor. Therefore, I give more weightage to the business qualities of a company than the industry it operates in. In fact, I follow Peter Lynch when he says that:
Moderately fast growers (20 to 25 percent) in non-growth industries are ideal investments.
I try to find a company, which has shown good growth of sales & profits in past years. I consider such a company a good investment candidate
irrespective of its industry. I try to focus on the performance of the company in comparison to its industry peers and try to find out if it has any business advantage over its peers.
Warren Buffett calls this business advantage “Moat”. Many investors visit company stores, manufacturing plants, meet its customers, suppliers, vendors etc. to find out the moat of a company. If time permits, an
investor should do these activities, as these will give her information that the stock markets are yet to come across. However, many individual investors including me, have limited time left after the daytime job and therefore, cannot go to the market and meet different stakeholders of the company. Therefore, I use consistent growth in sales in past as a
substitute of market research and try to analyse it further. If I find a company has been growing at a rate of 20% year on year for past 10 years whereas its peers are growing only at 10% or less, I analyse it further. If 10 year back it had a single manufacturing plant and it has increased its capacity to 5-6 plants now where it is able to sell the entire production of these 5-6 plants, then the company is bound to have a sustainable advantage “Moat”.
Moat can be discovered after doing market research if time permits but detailed analysis of past growth, other financial parameters like higher profit margins as compared to industry peers, can easily provide an investor the indication of a sustainable business advantage.
We have the advantage of witnessing one of the most severe recessions ever since 2008. It is blessing in disguise as we can analyse the
performance of any company during this recession and see how its
business fared. If it was able to show sustained growth during 2008-2014, it is expected to have a good business advantage, which has sustained it in bad times and it might help it to grow its business further when good times (Achche Din) arrive!
C) MANAGEMENT ANALYSIS:
Management is the most important parameters and I give it more importance than any other parameter. I want to invest in companies, which are run by honest people whom I can trust with my personal money. A crook manager will always find more than one way to cheat
shareholders. I avoid companies where I see even the slightest sign of compromise of integrity.
Management analysis is mainly a subjective exercise however; it contains some objective parameters as well. We should read profile of promoters, search about their credentials, any issues, penalties, regulatory actions etc. about them from public sources (e.g. google). We should do similar checks about independent directors as well. Once we are convinced that
there is nothing to question their character & integrity then we should move ahead with further analysis.
As an investor should stay invested in stocks of a company for decades, management succession plans become a vital factor. As in India, most businesses run in families, we should see whether the key promoter has introduced her next generation into business. We should read about the next generation. We should find out their education credentials and the amount of experience they have already had working under guidance of their parents.
Certain parameters like salary being paid to children of key promoter are good indicator of values being instilled by promoters in her children. I was amazed to find a company, which made about Rs. 50 cr. (INR 500 million) in profits but the promoter paid only Rs. 10,000/- (INR 0.01 million) per month to his daughter who had joined the board of directors. Today, I am heavily invested in the stocks of that company.
For any further information, we should always call the company secretary or investor’s relations officer of the company before we commit our hard-earned money to any stock.
Many objective parameters can provide indications about investor friendliness of the promoters & management:
A comparative analysis of salary drawn by promoters and the profits of a company is a good parameter. The promoter should not have a history of seeking increase in remuneration when the profits of the company declined in past.
Successful execution of increase of production capacity especially by green field plants is a good indicator of competent management. It is very good if the capacity addition has been done without facing any delays.
A company that has consistently increased its dividend payout with increase in profits in past, usually has a good management.
Purchase of shares of a company by its promoters is a sign of a good promoter. However, selling of shares by promoters is not necessarily negative. Company’s shares are usually promoter’s biggest asset and they usually sell it whenever any cash requirement arises in personal life.
D) VALUATION ANALYSIS:
There are many parameters, which need to be studied to analyse the valuation levels of a company. Some of the important parameters are:
Price to Earnings ratio (P/E): I believe that P/E is the single most important parameter to analyse whether stock of any company is
the current market price (CMP) of a stock by profit/earnings per share (EPS). It represents the price an investor pays to buy Rs. 1 of earnings. I prefer the companies, which are available at low P/E ratio, preferably less than 10.
Price to Book Value ratio (P/B): It is calculated by dividing the CMP of a stock with the book value (shareholder’s equity + retained earnings) per share. It represents the price an investor pays for Rs. 1 of net assets after settling all outsider liabilities of a company. I find P/B ratio irrelevant due to usage of historical cost of company’s assets while calculating book value. The historical cost might not represent the current market value of company’s assets. However, P/B ratio is very important for companies in financial sector where most of the assets are cash assets and book value is good indicator of net worth of the company.
Benjamin Graham said that an investor should look for companies where P/E * P/B is < 22.5. However, I focus mainly on companies with P/E <10 while ignoring P/B ratio.
Every investor develops her own parameters as her investing experience grows and I believe that every reader of this blog would be able to find her favorite parameter as she keeps analyzing more and more companies.
Market Capitalization: It represents the value of all the shares of a company and indicates the value for which the entire company can be bought at any point of time. Companies are divided into micro-cap, small-cap, mid-cap and large-cap based on their market capitalization. I prefer investing in companies, which are currently micro-cap or small-caps as these companies represent the section of economy, which can grow fast and become future large-caps.
There are many other parameters like return on equity (ROE), return on capital employed (ROCE), dividend yield etc. which are analysed by different investors to find out stocks which hold the potential for provide good returns in future. We would analyse many such factor in the
subsequent article in this series that would be dedicated to valuation analysis.
In the current article of this series “Selecting Top Stocks to Buy”, we discussed various aspects of analysis of any company. An investor should analyse the companies from each of these angles: financial, business & industry, management and valuation before she invests her hard-earned money in any stock.
The investor should realize that her rejection rate of stocks would always be high as good companies selling at attractive prices are always difficult to find. However, finding one good stock each year is more than sufficient. 10 good stocks in one’s lifetime can make one a billionaire. The investor
should never be in a hurry. She should learn to be patient and should hold the impulse to buy a stock if she does not find a good stock. The investor should have very strict stock selection criteria for adding stocks in her portfolio so that she can be confident that only right stocks are selected. Easy selection criteria will lead to many undesirable stocks in the portfolio, which will require selling soon after buying. This would lead to wastage of time and effort put in stock selection. The key is to find if company would survive for next 25-30 years and whether the investor can visualize it being there after many decades. Economic cycles of upturn and downturn will be there. A good company can weather all of them and come out a winner.
UNDERSTANDING THE ANNUAL REPORT OF A COMPANY
The current article of this series focuses on the annual report ofcompanies. This article seeks to describe the sources for getting the annual report and understanding various sections of the annual report along with their importance for an investor.
Annual Report
At the end of each financial year, every company is required by law to prepare a report for shareholders, which provides the details of
performance of the company over the year. This report is called annual report. Annual report is the single most important source of information for an investor. Importance of annual report to an investor is akin to alphabets for any language or periodic table for Chemistry.
The detailed analysis of any company starts with reading of the annual report of the company. I believe that if an investor does not read annual reports of companies, she would not be able to become a successful investor.
Sources for getting the annual report
An individual investor can get annual reports of any company from multiple sources. These sources are free as well as paid sources.
Free Sources:
Free sources are sufficient for most of the requirements of any individual investor. Some of the common sources are:
A) Company Website > Investor Section: This is the most common source and should be the first place to look for information about any company. Many companies provide annual report for almost 10-12 years on their website. Below is the screenshot of investor’s section on website of Larsen & Toubro Ltd, which provides annual reports from 2002 onwards. However, there are many companies, which do not publish annual reports at their websites. For example Mayur Uniquoters Ltd (MUL) does not have links for annual reports at its website.
Most of the companies, which lack annual reports on their websites, are small-cap and mid-cap companies, which are yet to have an investor friendly interface. As these companies grow in size, they start investing in public relations & investor friendly initiatives and improve significantly in dissemination of information. Therefore, the absence of annual reports on the website should not be seen negatively. It should be accepted merely as a phase in company’s life cycle. There are many other public sources from where we can get the required information. Some of such sources are mentioned below.
B) Stock Exchange Websites: Stock exchanges are an important source of information distribution for companies. Many stock exchanges around the world host much more information, financial and otherwise, about companies than mere press releases and corporate announcements. In India, Bombay Stock Exchange (BSE www.bseindia.com) is one such stock exchange, which provides annual reports as well as financial results of the companies listed on BSE:
C) Financial Websites: Many financial websites also provide annual reports of companies. e.g. www.moneycontorl.com. I have provided a screenshot of webpage providing links of annual reports for MUL on website of moneycontrol.com
Paid Sources:
The sources mentioned above are free sources available to any investor. Free sources of financial information are sufficient for most of the
requirement of individual investors. However, there are many paid sources as well that can provide the annual reports to investors. Some of such sources are:
http://www.reportjunction.com/ http://www.report.capitaline.com/
UNDERSTANDING THE ANNUAL REPORT
Annual report provides yearly account of performance of a company. We should read the annual report of a company with same vigor be it when analyzing it for investment for the first time or when monitoring it as part of our portfolio. While analyzing companies for first time investment, I prefer reading annual reports going back as far as possible, preferably for last 10 years or more.
Annual report contains financial as well as non-financial information about the company. Both financial and non-financial information are equally important for investors.
NON-FINANCIAL INFORMATION
A) Communications from Promoters and Senior Management:
Annual report is an yearly occasion when owners/managers communicate with the shareholders and inform them about the vision of the company, its performance during past year, its achievements, hurdles & challenges being faced, steps taken to overcome such hurdles, status of past
expansion plans & other projects undertaken by the company etc. Many promoters take this opportunity very seriously and inform the
shareholders about the company and their philosophy in such details that their communications become a collector’s affair. Warren Buffett is one such person. His letters to shareholders of Berkshire Hathaway as part of
annual report are read by investors world over. I would suggest that every person who wishes to be a successful investor in stock market should read all his letters.
The communication of a company’s management to its shareholders is a very important source for judging the status of the company as well as the industry. In fact, whenever I want to know about the status of any
industry, I read the annual report of any company belonging to that industry. One reading of management’s communication and the
Management Discussion & Analysis (MDA) section would give an investor an authentic brief snapshot about the industry and the company.
B) Directors' Report:
In this section, the directors as representatives of shareholders intimate them about the financial performance of the company during past year, status of projects under implementation, major customers, status of conversion of new customers, other major initiatives taken by
company. We should analyse the current performance of the company by comparing it with the outlook presented by directors in past years in the annual report. Special focus should be on the projects under
implementation. We should check whether company is able to finish projects on time and whether the company has abandoned projects
midway. I have provided below a snapshot of the director's report from the FY2013 annual report of MUL.
C) Management Discussion & Analysis (MDA):
MDA is another important section where management informs the shareholders about the business environment being faced by the
company. The management informs the shareholders about the industry outlook, company outlook, opportunities, challenges, risks, updates on research & development, human resources etc. A snapshot of the MDA from the FY2013 annual report of MUL is provided:
D) Details of Personnel in-Charge of running the Company:
The annual report provides details qualification of all the directors, key management people responsible for decisions of the company. It provides details of employees who are being paid in excess of Rs. 60 lakh (Rs. 6.0 million) per annum in annexure to director’s report and disclosures. Below screenshot provides details of salaries of most of the directors including promoter-directors of MUL for FY2013:
We get to know about the salary being drawn by most of promoter directors in this section. We can analyze whether salary drawn is in line with the industry norms/profits of the company.
In case of a company, Ambika Cotton Mills Ltd (ACML), I was surprised to see that the salary being drawn by promoter-chairman & managing
director (CMD) was Rs. 75 lakh (Rs. 7.5 million) per annum and the salary of his daughter who was working as executive director was Rs. 1.5 lakh (Rs. 0.15 million) per annum. In FY2013, ACML had reported sales of Rs. 400 crore (Rs. 4,000.0 million) and net profit of Rs. 31 crore (Rs. 310.0 million). Salary being drawn by the promoter’s daughter was mere Rs. 12,500 per month, which is equal to any lowest level employee of any government organization in India. The screenshot from annual report of ACML for FY2013 showing salaries of Mr. Chandran (promoter-CMD) and Ms. Bhavya (his daughter, executive director) is given below:
E) Report on Corporate Governance:
This section contains the details composition of board of directors, quorum of various committees of the board, attendance record of various directors in different meeting, details of past and upcoming annual general
meetings, information of listing on various exchanges, past dividend
record, proposed dividend, stock market data, distribution of shares etc. It also contains details of registrar & transfer agent of the company.
Following screenshot from 2013 annual report of MUL shows the
attendance of composition of board and attendance of directors in last AGM:
F) Notice of Annual General Meeting (AGM):
This would contain the information about the upcoming AGM as well as different decisions that require shareholder’s ascent by way of a vote. We get to know of salary hike sought by promoter managers, plans of taking further debt, new expansion projects, entry of next generation of leaders in board positions etc by the items listed to be voted in AGM.
FINANCIAL INFORMATION
The annual report contains almost entire financial data that an investor needs to form her views about the company:
A) The Independent Auditor’s Report: The financial section starts with the report of an independent auditor in which an independent entity provides its views about the financial information presented in the annual report. Auditor’s report comments on the key items like any deviation
from the accepted accounting practices, any amounts that are not paid to government authorities, any default in payments to lenders, sufficiency of control systems to the size of the company, any frauds conducted by company or its employees, proper utilization of funds raised by company from lenders/IPOs etc.
Auditor’s report gives you a snapshot of authenticity of financial information that follows in the annual report.
B) Financial Statements:
These consist of three important sections: balance sheet, profit and loss statement and cash-flow statement. Financial statements of current year are always shown in parallel to figures of previous year so that
performance of current year can be compared with immediately preceding year.
1) Balance Sheet:
This section of financials provides details of all the assets and liabilities of a company at the last date of the financial year. Liabilities are the sources of funds, which a company has utilized to purchase all the assets it owns.
Balance sheet of MUL at March 31, 2013 is shown below:
We can see the comparative position of MUL at March 31, 2013 & March 31, 2012 and observe the way the balance sheet size has increased from Rs. 15,3850.16 lakh (Rs. 1.58 billion) to Rs. 21,349.20 lakhs (Rs. 2.13 billion). Almost half of the increase of Rs. 5,499.04 lakhs (Rs. 0.54 billion) has been contributed by increase in reserves & surplus by Rs. 2,700 lakhs (Rs. 0.27 billion). This is a sign of healthy growth by a company.
2) Profit & Loss (P/L) Statement:
This section of financials provides details of total sales that a company has achieved in a year and all the expenses the company has incurred to achieve these sales. The balance after expenses and taxes constitutes the net profit for the shareholders. Given below is the P/L statement of MUL for FY2013:
We can see that total revenues have grown by 20% from Rs. 31,909.37 lakh (Rs. 3.19 billion) in FY2012 to Rs. 38,327.47 lakh (Rs. 3.83 billion) in FY2013. Such revenue growth is very good. On top of it, we can see that in the same period net profit has grown by 30% from Rs. 3,3337.06 lakh (Rs. 0.33 billion) in FY2012 to Rs. 4,362.55 lakh (Rs. 0.44 billion) in FY2013. This higher growth in net profit is an indication of improvement in operating efficiency of the company.
3) Cash-Flow Statement:
This section provides details of the cash that a company has generated in last financial year from operation (cash-flow from operations or CFO). This section also includes details of cash used in making investments or
received from selling investments (cash-flow from investing activities or CFI) and cash raised from financial institutions as borrowings or repaid to
them during the last year (cash-flow from financing activities or CFF). Given below is the cash-flow statement of MUL for FY2013:
We can see that in FY2013, MUL generated Rs. 2,723.54 lakh (Rs. 0.27 billion) of cash from operations and raised Rs. 766.70 lakh (Rs. 0.07 billion) of cash from financing and used it for investing Rs. 3,586.26 lakh (Rs. 0.35 billion) in assets of the company. Thus, we can observe that MUL has funded most of its investments in FY2013 from its operations (aka internal accruals), which is a sign of healthy growth.
C) Schedules/Notes to Financial Statements:
Schedules contain the detailed breakup of numbers shown in financial statements. They are an integral part of financial statements and are studied along with financial statements to get better understanding of financial statements. For example, if we want to see the details of long term borrowings in the balance sheet of MUL shown above, we should refer to note/schedule no.5 of the annual report of MUL, for more details:
Thus we get to know the details of the lenders, their respective loan
amounts, repayment schedules and the security offered for different loans availed by company from its lenders.
If we want to see whether MUL has invested in a new plant/assets during the year, then we can see its details in schedule/note on fixed assets:
We can see that the company has invested Rs. 1,493.94 lakh (Rs. 149.3 million) in current year, which was mainly invested in building & premises and plant & equipment. It indicates that the company is probably
year in the last row, then we realize that last year the company had invested Rs. 1,772.80 lakh (Rs. 177.2 million) in its assets. This gives an investor an indication that the company is in the expansion phase and continuously investing in assets.
Schedules/Notes are very important and should be studied with patience and due care. Quality of schedules is an important reflection of the quality of management of the company. Warren Buffett says that if you are
unable to understand the notes, it is because the CEO does not want you to understand them. A lot of information/financial jugglery is often hidden in schedules.
D) Related Party Disclosures:
Every company is required to disclose every transaction it enters into with its promoters and other related entities. A careful analysis of these
transactions can reflect whether the promoter is using different
transactions to transfer money from the company to itself. We should look at the transactions between company and promoter owned entities (POE, enterprises over which promoters are able to exercise significant
influence). Presence of transactions like interest free loans to POE, taking assets owned by POE on lease/purchase at prices higher than market value are some of the examples by which we can get a sense of
promoters who are taking out funds from the company and gaining at the cost of minority shareholders.
Thus, we can see that the annual report is one such document that can throw light on the status of the company, provide information to gauge its potential of future growth and provide insight on the character of the management of the company. It is single most important document that every investor should read.
Future articles in this series would build upon the understanding of annual report to further the discussion on financial, business & industry,
management and valuation analysis of companies. We would learn in detail about the concepts and parameters of such analysis by applying it to analysis of a sample company.
